Archive for the ‘Currencies’ Category

Below are some key points from a New York Times article on some worse than expected problems in Spain:

Spain’s prime minister, Mariano Rajoy, already under pressure from his European counterparts to clean up Spain’s banks and public finances, failed on Thursday to ease what has recently turned into his biggest domestic political challenge — a separatist push by the nation’s most economically powerful region, Catalonia.

Just as Mr. Rajoy’s government finds itself on the front lines of the euro crisis, Catalonia, which accounts for almost a fifth of Spain’s economic output, has moved to the fore of Mr. Rajoy’s domestic challenges.

“The demands from Catalonia have developed a lot faster than anybody expected,” said Jordi Alberich, director general of the Cercle d’Economia, a Barcelona business organization. “A difficult crisis situation for Mr. Rajoy has just now got a lot more complex.”

Although Catalonia is not set to hold another regional election until 2014, the dispute with Mr. Rajoy is expected to convince Mr. Mas to call another election before the end of the year, in the hope that his Convergencia i Unió party could capitalize on recent opinion polls showing a rising majority in favor of independence.

Spain has the fourth-biggest economy in the 17-nation eurozone, almost five times larger than that of Greece, and the 13th largest in the world. A failure on the part of European leaders to help Spain through its troubles, and a failure on Spain’s part to execute its ambitious economic reform plans, might wreck Europe’s monetary union and destabilize the global financial system.

Another story on bond buying, which leans bullish for risk assets. While anything can happen, an announcement confirming this approach could spark a big short-covering rally. From Reuters:

European Union leaders are likely to discuss the possibility of the euro zone’s bailout funds buying Spanish and Italian bonds as they are issued, to help ease funding costs for Rome and Madrid, EU officials said on Thursday. The temporary European Financial Stability Facility (EFSF) and its replacement, the European Stability Mechanism (ESM), have a mandate to buy bonds of euro zone countries directly at the primary auction.

From afar the elections in Greece seem to have taken the cataclysmic Greece-leaves-the-euro scenario off the table. In reality, Greece’s stay in the euro remains far from certain. On Sunday morning, Reuters reported what could be interpreted as “we are pushing you out” comments from Germany:

Greece’s new government should stop asking for more help and instead move quickly to enact reform measures agreed to in return for previous bailouts from its European partners, German Finance Minister Wolfgang Schaeuble said on Sunday. Schaeuble told Bild am Sonntag in unusually blunt language that Greece has forfeited much of Europe’s trust during the sovereign debt crisis, as reflected in an opinion poll covering the euro zone’s four biggest nations and published in the paper. “The most important task facing new prime minister (Antonis) Samaras is to enact the program agreed upon quickly and without further delay instead of asking how much more others can do for Greece,” said Schaeuble, a close ally of Chancellor Angela Merkel and Europe’s most powerful finance minister.

Why would Germany want to push Greece from the euro? Ezera Klein outlined one common theory on the Washington Post’s blog:

You might ask why they seem so intent on cracking Greece in half. One plausible story I’ve begun to hear is that an increasing number in the euro zone actually want to drive Greece out. The idea, basically, is that Greece is such an unsalvageable basket case, and its economy is so much weaker than anyone else’s, and its governments have been so much more dishonest and difficult to deal with, that solving Greece’s problems would mean rewarding irresponsibility while not solving them would mean an endless cycle of crisis. At some point, it’s better just to cut them off and cauterize the wound. At that point, having shown how serious they are about punishing wayward members, the euro zone can extend more support to the remaining, and more responsible, countries in the currency union. Having made an example out of Greece, and forced everyone to stare into the abyss, they will both have more support for saving the rest of the periphery and less fear that other countries will think they can flout the rules without consequences.

The markets were given some reason to hope when the Guardian reported Germany had softened its stance on how bailout funds could be deployed. Like most stories from Europe in recent years, Angela Merkel stamped out those hopes. Germany does not have unlimited resources. Currently, there is little in the way of consensus relative to the next steps to stem rising bond yields in Spain and Italy, which could make for a rocky ride in the coming week.

Following the typical script, European leaders may only take action after being pushed to the edge of the cliff by the financial markets. As we noted Friday, despite the back-of-the napkin approach to crisis management, numerous markets have held above important technical levels, which still gives the nod to the bulls. However, market charts have deteriorated to a point where understanding bull/bear demarcation points are prudent.

Merkel rejected joint debt issuance in the 17-nation euro area as a solution, saying “under no circumstances” would she agree to Germany-backed euro bonds. Some “come along and ask for euro bonds, saying all we need are equal interest rates and everything will turn out all right,” Merkel said in a speech to members of her Christian Democratic Union in Berlin yesterday. Instead, what’s needed is an economic overhaul to tackle the lack of competitiveness in Europe, she said.

Markets love bailouts, but the story behind today’s story paints a concerning picture. From the Wall Street Journal:

The European department of the International Monetary Fund has started discussing contingency plans for a rescue loan to Spain in the event that the country fails to find the funds needed to bail out its third-largest bank by assets, Bankia SA, people involved in the handling of the Spanish crisis said Thursday.

A major issue in any bailout of Spain, which could end up being bigger than those already agreed for Greece, Ireland and Portugal, would be the size of the contributions made by the IMF and the EU and where those funds would come from.

“A bailout loan could stretch the resources of both the IMF and the euro zone to breaking point and raise serious questions about the purpose of the euro,” another of the people said.

“Neither the IMF, nor the euro zone, can shoulder this bill with three other euro-zone bailouts in progress. The money is simply not there,” a second person said.

Before the markets opened on May 30, a Dow Jones article captured the serious nature of the escalating crisis in Spain:

European stocks fell Wednesday as the euro sank to its lowest level since July 2010 and Spanish bond yields soared, with concerns over Spain mounting. “Investors are heading for the exits once again as fears for a Spanish economic collapse heads closer to becoming a reality,” said Mike McCudden, head of derivatives at Interactive Investor. “It appears to be only a matter of time before it’s not just the banks that need bailing out, but the country itself,” he added.

“The ECB’s rejection of the Spanish government’s plan to recapitalize Bankia…puts Spain on the steps of the region’s fiscally based liquidity hospital, the European Financial Stability Facility/European Stability Mechanism. It looks increasingly likely that it will be knocking on the door soon asking to be admitted,” said JPMorgan. “Spain looks to have gotten to the point where it cannot bear the burden alone. The Spanish government recognizes the need for burden-sharing, but it does not want the kind of burden-sharing that was made available to Greece, Ireland and Portugal,” it added.

The markets in the U.S have been relatively calm having avoided new lows for six trading sessions. U.S. investors expect the European Central Bank (ECB) to bail out the markets once again. As we outlined in detail on May 26, the market may be underestimating the problems associated with the narrowing list of possible policy responses in Europe.

As shown in the chart below, on Wednesday morning the yield on a ten-year Spanish bond hit 6.70% for the first time since November 2011. If the ECB had a “solution” with little in the way of negative consequences, it is logical to assume they would have acted already. The ECB will take action at some point, but the low-hanging fruit is no longer on the policy-response tree.

The European Commission called for direct euro-area aid for troubled banks and touted common bond issuance as an antidote to the debt crisis now threatening to overwhelm Spain. The commission, the European Union’s central regulator, sided with Spain in proposing that the euro’s permanent bailout fund inject cash to banks instead of channeling the money via national governments… Proposals for more liberal use of European bailout money are likely to face resistance in creditor countries such as Germany, Finland and the Netherlands, the scenes of growing taxpayer opposition to more aid.

Since they are all flawed in some way or involve having Peter bail out Paul, the expression “likely to face resistance” has been common in recent media reporting. When push comes to shove, Europe will do something. The question is how low do the markets have to go to qualify as a shove.

The tables below, originally shown on May 26, have been updated as of the May 29 close. Even while the S&P 500 tacked on 14 points, Treasury bonds (TLT) and the U.S. Dollar (UUP) had very modest declines showing risk-averse investors were not impressed with the “good” news from Greece and the Wall Street rumor of a giant stimulus package coming from China. The tame reaction from TLT and UUP was one of the reasons we did not buy into Tuesday’s rally.

While the S&P 500 and EWG recaptured two of the support levels in the table below on Tuesday, it appears as if those levels will be surrendered early in Wednesday’s session.

(Reuters) - Euro zone officials have told members of the currency area to prepare contingency plans in case Greece quits the bloc, an eventuality which Germany’s central bank said would be testing but “manageable”. Three officials told Reuters the instruction was agreed on Monday during a teleconference of the Eurogroup Working Group (EWG) - experts who work for the bloc’s finance ministers. “The EWG agreed that each euro zone country should prepare a contingency plan, individually, for the potential consequences of a Greek exit from the euro,” said one euro zone official.

A well-connected writer for the Telegraph, Ambrose Evans-Pritchard, reported the following European proposals are being pushed this week:

The eurozone’s ‘Latin Bloc’ is in full revolt. The trio of French, Italian, and Spanish leaders - backed by world powers - are to push for a radical shift in Europe’s economic strategy at crucial summit on Wednesday. The package of measures includes an EMU-wide guarantee of bank deposits aimed at halting a slow bank run across southern Europe, as well as demands for full activation of the European Central Bank as a lender of last resort. They will propose eurobonds to finance an infrastructure blitz, a sort of Marshall Plan to revive confidence even if long-term benefits will take years to feed through.

Mr Hollande is balking at the coronation of German finance minister Wolfgang Schaeuble. “It is a litmus test. Hollande is flexing his muscles, showing that he is willing block the man seen as Europe’s symbol of austerity,” said Mats Persson from Open Europe. “The real battle is over the ECB. It is the only body that can act swiftly enough to underwrite the bond markets. But the crisis may have to get far worse before the Germans yield. It will take immediate contagion, far beyond Greece.”

Obviously, adoption of any of these proposals would be positive for U.S. stocks (SPY), and foreign stocks (EFA). The impact on the euro (FXE) could be mixed since additional money printing for the ECB is a doubled-edged sword helping keep the EU together, but possibly hatching the seeds for future inflation. The entire article is worth a look.

An Associated Press article threw some cold water on the idea of jointly-issued European debt:

Germany is making clear ahead of a European Union summit that Chancellor Angela Merkel’s government remains staunchly opposed to the idea of jointly issued bonds for the 17-nation eurozone.

The gravity of the global debt crisis can be seen in the flip-flop game plans from policymakers. The reaction to the 2008 crisis was to try to “spend our way out of this”. That didn’t work, but it did succeed in pushing debt levels even higher. The second approach, championed by Germany’s Angela Merkel, is based on the “cut spending and restore confidence” theory. That isn’t working either.

Now we have come full circle with Tim Geithner and the IMF again calling for “pro-growth” policies. Pro-growth is a politically correct way of saying “spend money we don’t have.” According to the Wall Street Journal (WSJ), the Keynesian approach of the government leading the private sector to the promise land of growth, is now being embraced by the most broke nation of them all – Greece:

Mr. Tsipras, the head of Greece’s left party and an engineer by training, recommends a stimulus package to boost the Greek economy and has called for tearing up the country’s existing austerity-for-loans program. He has suggested scrapping plans to lay off 150,000 public-sector workers by 2015, and repealing recent measures to push down private-sector wages. He favors nationalizing the banking system so as to better direct lending policies, and speaks favorably of Franklin Delano Roosevelt’s Depression-era New Deal program and President Barack Obama’s stimulus package—something Mr. Tsipras said is lacking in Europe.

As we outlined in October 2011, the debt levels of many nations have moved into unsustainable territory. Thus, it is not surprising that policies from both ends of the spectrum have failed. Mr. Tsipras is also engaging in a full-tilt game of political chicken. From the WSJ:

The head of Greece’s radical left party—throwing down a gauntlet that could increase tensions between Greece and its frustrated European creditors—said he sees little chance Europe will cut off funding to the country but that if it does, Athens will stop paying its debts.

The video below looks at the current state of the markets (SPY) as we head into a G-8 weekend. Risk assets are oversold, but remain in prove-it-to-me mode. We will continue to err on the defensive side until the market or policymakers show us something of substance.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.